Incentive Pay Term Paper

Pages: 8 (2647 words)  ·  Bibliography Sources: 8  ·  File: .docx  ·  Level: College Junior  ·  Topic: Business

For high-performing people with a high level of control, stock options can provide significant incentive for performance. In other words, stock options can "amplify the implications of executive ability, such that option-heavy incentive schemes will increase the performance of talented executives but worsen the performance of low-ability executives" (Wowack & Hambrick, 2010).

However, the role of stock options changes when one looks at different levels of employees and how those employees interact with the company. It has already been established that providing the CEO or outside directors with stop options increases risk taking, and that this impact is stronger for outside directors than it is for a CEO (Deutsch et al., 2010). Interestingly enough, the effects are not cumulative, but substituting. "If both the outside directors and the CEO are provided with stock option compensation, outside directors incentives weaken the effect of the CEO's incentives on firms' risk taking" (Deutsch et al., 2010). Of course, risk-taking behavior cannot be substituted as a measure of performance. In some circumstances, risk-taking will improve firm performance, but, in other circumstances, risk taking is going to decrease performance. That is the nature of risk. Moreover, this may not translate to employees below the executive level because the lower the employee, the less likely the employee is to be able to engage in risk-taking behavior because of more constrained options. Therefore, one cannot assume that the impact of strategic compensation strategies like stock options on executives will translate to other levels of employees.

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Of course, it is critical to recognize that strategic compensation practices are not applied universally across firms. While there are a wide variety of business ownership forms available, in many ways they come down to two different types of firms: family owned and non-family owned firms. As one might anticipate, the level of family involvement in a firm impacts its use of strategic compensation. Nepotism helps explain this in many ways, since one would expect performance to be less important than family relationships in firms that exist, in many ways, to provide a means of support to the family structure. The greater the involvement of founding family members in the top management team, the less likely the top management team is to use performance measures in its strategic target setting and incentive practices (Speckbacher & Wentgas, 2012). This is especially true, as one might expect, in smaller firms, with increasing firm size having a moderating impact on the negative correlation between family involvement in the top management team and the use of performance measures in strategic target setting (Speckbacher & Wentgas, 2012).

International Studies

Chenevert and Tremblay examined strategic compensation in Canadian firms and found that a complex incentive pay structure is not necessary to encourage performance (2009). Instead, as long as a compensation strategy provides support for good working conditions or there is a way to use financial incentives, then one can anticipate a positive impact on employee job performance (Chenevert & Tremblay, 2009). What this suggests is that incentive pay structures can be effective even if they are simple. In fact, it may be that simple structures, which clearly reward strong performance, are more effective than more complex structures that do not clearly and quickly reward strong performance.

Of course, examining international results may or may not be beneficial when looking at U.S. compensation strategies. Even with the adoption of the Affordable Care Act, which, in many ways, makes health insurance affordable for people who would not otherwise be able to afford it if not employee sponsored, the reality is that in the United States the extent of health care coverage is still a significant employee benefit. In other countries, like Canada, this incentive does not exist, since all people have access to universal healthcare resources. Removing this external benefit may give greater weight to employee compensation packages, even packages that exist outside of a benefits package. For example, whether an employee is compensated in cash or through a superior insurance package, if minimum deductible amounts still vary by thousands of dollars, then money may have more of an impact on people in companies in the United States because of lingering concerns about access to basic healthcare, even if people no longer have the concerns about access to catastrophic healthcare resources.


Strategic compensation programs do not only look at actual employee pay, but at the entire compensation package including benefits, health insurance, retirement benefits, and other means of compensation. However, it is important to keep in mind that the actual compensation is only one part of the compensation package. The entire corporate structure has to be considered when developing a strategic compensation practice. How much risk does the company want to take? Are the directors of the company interior or exterior to the company? What size is the company? How many different levels of employees are in the company? How specialized are the skills that employees will need to perform up to the standards set for the compensation program? What type of training does a company provide to ensure that employees can hit performance measures? What types of differences are there between employee pay and pay at executive or manager levels? Will same-level employees receive the same type of compensation programs? Do incentive pay structures ensure that employees are still adequately compensated during anticipated or seasonal lulls in performance? How do these compensation programs interact with benefits that are exterior to the business? All of these questions must be considered when determining the appropriate compensation strategy.


Berrone, P. & Gomez-Meija, L.R. (2009). Environmental performance and executive compensation: an integrated agency-institutional perspective. Academy of Management Journal, 52(1), 103-126.

Chen, C. & Huang, J. (2009). Strategic human resource practices and innovation performance:

the mediating role of knowledge management capacity. Journal of Business Research, 62(1), 104-114.

Chenevert, D. & Tremblay, M. (2009). Fits in strategic human resource management and methodological challenge: Empirical evidence of influence of empowerment and compensation practices on human resource performance in Canadian firms. The International Journal of Human Resource Management, 20(4), 738-770. doi:10.1080/09585190902770547

Deutsch, Y., Keil, T., & Laamanen, T. (2010). A dual agency view of board compensation: the joint effects of outside director and CEO stock options on firm risk. Strategic Management Journal, 32(2), 212-227.

Larkin, I., Pierce, L., & Gino, F. (2012). The psychological costs of pay-for-performance:

Implications for the strategic compensation of employees. Strategic Management Journal, 33(10), 1194-1214.

Lopez-Cabrales, A., Perez-Luno, A., & Cabrera, R.V. (2009). Knowledge as a mediator between HRM practices and innovative activity. Human Resource Management, 48(4), 485-503.

Speckbacher, G., & Wentges, P. (2012). The impact of family control on the use of performance measures in strategic target setting and incentive compensation: a research note. Management Accounting Research, 23(1), 34-46.

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APA Style

Incentive Pay.  (2014, September 28).  Retrieved September 23, 2020, from

MLA Format

"Incentive Pay."  28 September 2014.  Web.  23 September 2020. <>.

Chicago Style

"Incentive Pay."  September 28, 2014.  Accessed September 23, 2020.